I am not sure I fully agree with this BlackRock chart — there are times when cash makes sense. However, I cannot disagree with the takeaway that you cannot sit in cash for very long stretches of time (years) and expect any sort of return above inflation.

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

Good post. Cash alone is not an investment. Having access to cash (via govt bonds) is necessary for making an opportunistic investment play. And this is the conundrum that some investors have: where do you park “cash” at a positive rate of return?

This is explained by labor and capital having two different natural rates of interest. Capital’s natural rate is higher, around 6%. Labor’s is low, between 0% and 1%. The Fed funds rate and inflation follow labor’s natural rate. The issue here is that bond yields need to be around 6% for there to be equilibrium in the money market for “capital’s” natural rate. With yields so low, there is excess cash, lots of it. Excess cash pushes down the return on cash even more as an investment compared to bond yields. From a preliminary calculation, the Fed rate should be at least above 1% to balance this effect.http://effectivedemand.typepad.com/ed/2013/06/is-lm-curves-for-capital-labor.html

Much of the long-term savings are held in tax-deferred accounts these days (except for the top couple of percent). So, it would need to be looked at in light of no taxes except for ordinary income tax at the end of the holding period over the past few decades.

It also appears that they are using straight returns without taking fees, expenses, and survivorship bias into account. It would have been very difficult to have an all-stock portfolio from 1926 to now without significant expenses (at least 1% a year until the past couple of decades) with brokerage commisions and/or management fees. Even re-invested dividends would have incurred broker commissions before the advent of mutual funds. You would also have had to make sure that you moved out of the stocks in the DJIA and S&P 500 when the indexes moved out of them or a number of them would have gone bankrupt with 100% loss of your money in those units.

The expenses and survivorship bias would have been much more favorable with bonds and cash would have, by definition, been almost totally liquid and once FDIC came to be, would have had minimal danger of losses as long as you stayed under the limits by diverisfying accounts and institutions.

No, you can’t just sit in cash forever. But if you are highly risk-averse, then spending a lot of time in cash makes sense. To compensate, just buy-low sell-high with stocks or other risk assets now and then. Buying at the bottom (actually buying on the way down, since timing the bottom perfectly is impossible) is not that difficult if you’ve been sitting in cash, anxious to buy, for a long time. Nor is holding 100% stocks difficult, if you’ve promised yourself to sell once the price goes up. I’ve sat in cash or bonds for most of my life, most of the time, and still gotten a very good long-term record, by simply taking advantage of occasional fire-sales to buy stocks cheap, then switching back to cash or bonds as soon as it makes sense. The equity risk premium is only about 3% compared to bonds. So all it takes is buying at a 30% off sale every 10 years, then selling once the sale is over, and you gain back all that risk premium and then some without actually spending much time holding stocks. (I’m over simplifying since there are currently tax advantages to dividends vs interest, capital gains taxes is a factor, and so on).

Cash is a drag; as in, if you have an inordinate amount — 20,30, 40% — while being otherwise fully invested, your returns will lag the averages. Yes, we all know this. But for sheer nimbleness it cant be beat. And taken in the context of the excellent post “Time … is on your side,” I argue for an opportunity allocation in cash for just the opportunities bonzo, above, is arguing for. And when comparing results, I like cash for its risk-adjustment contribution.

In addition to the various reasonable arguments for holding cash above, here’s another case when it works to one’s favor.

The Fed is distorting high-quality short-term bond rates, so that currently, one needs to buy a fund with a two-year duration to get a yield to maturity of 1%. A half-percent move up in rates negates a year’s income. Alternatively, you can shop for select banks and credit unions paying 1% on insured savings accounts, with no risk to principal. There are also CDs with low penalties for early withdrawal that can work slightly better. Best place to shop: depositaccounts.com.

The insurance is limited to $250K per institution, but if you play your cards right with multiple or Trust accounts, you can get it up to $500K or $1mm. Most advisors are reticent to do this because the cash cannot be at the same custodian as the other assets, and they don’t like seeing assets leaving the house.

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About Barry Ritholtz

Ritholtz has been observing capital markets with a critical eye for 20 years. With a background in math & sciences and a law school degree, he is not your typical Wall St. persona. He left Law for Finance, working as a trader, researcher and strategist before graduating to asset managementRead More...

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